The Tax Cuts and Jobs Act created hundreds of changes to the U.S. tax code and will affect every taxpayer in America. The changes range from eliminating or lowering exemptions and special tax credits to increasing the standard deduction. The new tax law also re-did the tax brackets and changed the tax rates for some people and businesses. One of the changes most people don’t know about is the 20% Qualified Business Income Deduction. This is a provision meant to benefit businesses with pass through income and is effective from 2018 until 2025.
The Qualified Business Income deduction allows individuals a deduction of up to 20% against income from pass-through businesses. The deduction can potentially decrease the effective tax rate on business income to 29.6% for those in the top bracket. Qualified Business Income (QBI) is generally ordinary income earned by a business within the United States. It does not include investment items such as interest, dividends or capital gains and it does not include wages earned as an employee or retirement income.
Business with pass-through income that will qualify for the 20% Qualified Business Income Deduction include partnerships, S Corporations, and Sole Proprietorship. To Qualify for the QBI deduction, the taxpayer’s income must be below the “Threshold Amount”. The Threshold Amount is $315,000 for Married Filing Joint taxpayers and $157,500 for all other filers.
For individuals with taxable income below the Threshold Amount, the deduction is the lesser of 20% of the QBI from passthroughs or 20% of the following formula-taxable income less net capital gains. Taxable income is calculated after above-the-line deductions and either the standard deduction or itemized deduction. The deduction may be limited when taxable income exceeds the threshold amount by $100,000 for Married Filing Joint filers and $50,000 for all other filers. If certain criteria are not met, the deduction can be lost entirely when taxable income exceeds the upper limits of $415,000 for Married Filing Joint filers and $207,500 for all other filers.
Taxpayers with income above the upper limits must meet two requirements to qualify for the deduction. First the income may not be generated by a “Specified Service Business” and the “Qualified Trade or Business” generating the income must either pay wages or own property. A Specified Service Business (SSB) is defined as any trade or business involving the performance of services in the following fields:
- Actuarial Science
- Performing Arts
- Financial Services
- Brokerage Services
- Investment Management
- Trading or Dealing in Securities
Any trade or business where the principal asset is the reputation or skill of one or more of its owners or employees. Any business that is not an SSB is considered a Qualified Trade or Business (QTB). It is important to identify whether a business is a SSB or a QTB in order to determine whether the income from that business will qualify for the deduction when the taxable income is above the threshold amount.
For taxpayers with QTB income over the upper limit of the Threshold Amount, the 20% deduction is subject to the following calculation. The 20% deduction on QBI is limited to the greater of either 50% of allocable W-2 wages paid by the business or 25% of allocable W-2 Wages plus 2.5% of Qualified Property owned by the business. This means, for taxpayers with taxable income above the Threshold Amount, the QTB must pay wages to employees or own property, otherwise the deduction will not be available.
The QBI deduction is dictated by the income level of the taxpayer, whether the entity is an SSB or QTB, the entity structure of the business generating the income, whether or not the business pays wages or owns property.
It’s important to take full advantage of the new provision because it offers benefits that you could miss out on. The new QBI deduction can result in significant tax savings. To maximize the benefit however, there may need to be some business restructuring done. For example, you may come up with some income reduction strategies to stay below the income threshold. Or you might re-categorize income from a specified service business into non-specified service business income. You may even try hiring more W-2 employees or owing property.
If you’re not sure if you would be eligible for the 20% deduction, Polston Tax can help! Our tax attorneys and accountants have reviewed the new tax law and know what changes some companies need to be making. You can also read about other changes due to the Tax Cuts and Jobs Act here. Give us a call at 844-841-9857 or click below to schedule your free consultation!